Definition Of Risk In Insurance: Uncertainty and Loss

I’ll bet, when you do a survey of the best insurance books, there’s a difference in agreement on the definition of risk. Although the books are well-known books used as a learning resource in universities.

definition of risk in insurance

Photo by danxoneil Car crash is one of the risks that must be faced by the driver.

Uncertainty and Loss In Definition of Risk

Nevertheless, the theoretical insurance agrees that there are two elements contained in each definition.

The elements are:

  • Uncertainty
  • Losses

Uncertainty

Uncertain results are implicit in all definitions of risk. But certainly, the result should be questioned. You should know that two possible outcomes can occur when risk is declared to exist.

However, when you know for certain that a loss due to something will happen then the risk can be declared non-existent.

Another example is the depreciation of the capital market. Here, because of physical depreciation, the value will decrease. In other words, this is a sure thing to happen so there is no risk.

Loss

Basically, these losses are generally accepted. Such a gain is smaller when compared to the possible profits. Or in other words, an individual lose something valuable. In fact, this may not happen.

This is an undesirable outcome of the many possible outcomes that can occur.

For example, when you are a driver. You drive your car out of town. There are various possibilities that can happen. One possibility is your car crashed and damaged.

This is a reasonable thing. Though you know, you may not experience a collision and get to the destination safely. Car crashes are a risk that causes losses. And car insurance companies will bear the loss.

Deeper Into The Risk

Since we live in the real world then so are the risks that may occur based on that. More specifically, the risk is a deviation that occurs from the desired or targeted results. In other words, there is the possibility of exposure from unexpected conditions.

Due to conditions in the real world can be very complex, then the various combinations that lead to potential losses it is definitely there. This is because of the influence of the external environment.

So, when an event takes place, then there are two possibilities that can happen that is a loss or not. Measuring a possibility is not a requirement. However, this must exist. The degree of risk is something that may or may not be measurable. Thus the probability for adverse outcomes is between zero and one.

Losses are an undesirable event and this is a deviation from the expected result. You are like everyone else, of course, hoping not to suffer misery. However, when these expectations are not met, then this is a risk.

The following is a concrete example of the definition of risk.

When you have good health, you certainly hope not to get sick. If you own a house, you hope your house is not damaged by a disaster. However, there are of course some things that are beyond your control that can lead to potential losses or risks.

When you go to an insurance company then the actuary will predict the amount and value of any losses you may encounter. Next, they will charge a premium based on that value. The total of the amount of the predicted loss is the value desired by the insurer. The negative deviation from the expected result is called the loss by the insurer.

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